Shareholder activism is an investment strategy that investors such as hedge funds (HFs) use to increase the value of their investment by intervening in the management of a targeted firm. Activists can nudge management to take shareholder-friendly actions such as increasing dividends or share buybacks, doing spinoffs, or being acquired. Prior studies (reviewed by Brav, Jiang and Kim, 2009, 2015b) find that HF activism is quite successful in increasing shareholder wealth of targeted firms. However, there are two opposing views about how that happens. In the first view, activism increases the value of the target firm by enhancing firm productivity or promoting its takeover (see, e.g., Brav, Jiang and Kim, 2015a; and Boyson, Gantchev and Shivdasani, 2017). The second view is that shareholder gains from activism are due to wealth transfers from other stakeholders such as bondholders or employees (see, e.g., Klein and Zur, 2011; Coffee and Palia, 2016; and Brav, Jiang and Kim, 2015a). The two views suggest radically different implications about the value of activism for targets and society. If these gains arise, e.g., from operational efficiencies or facilitating a higher-valued takeover, HF activism is good for firm value and society. If shareholder gains are merely the result of wealth transfers from other stakeholders, the value of activism is less clear.
In a recent study, we aim to uncover the role of HF activism on the welfare of employees. Brav, Jiang and Kim (2015a) find that HF activism decreases productivity-adjusted wages for workers. Except for this study, empirical evidence on the effect of activism on employees is quite limited. More important, to our knowledge, no prior study has analyzed the effect of HF activism on employee pensions. Our paper aims to fill this gap. Specifically, we study whether HF activism helps or hurts employees’ wealth as represented by the health of their defined benefit (DB) pension plans.
Anecdotal evidence suggests that HF activism hurts employee welfare. A story in the New York Times offers a vivid example of this phenomenon. In 2012, Relational Investors, an activist fund, identified Timken Corporation, a steel and bearings maker in Ohio, as a target. In the summer and Fall of 2012, Relational started buying Timken stock. In November 2012, Relational publicly disclosed a 6 percent equity stake in Timken and launched an activist campaign against it. By September 2013, Timken was forced to replace its CEO. In an investor presentation in November 2014, Timken reported that, under the new CEO, the firm had almost eliminated its employee pension contributions, which dropped from a third of cash flow to near zero, and planned a large buyback of shares by the end of 2016.
Consistent with this example, we find that employees of target firms that sponsor DB pension plans suffer from greater plan underfunding after HF activism. This finding is consistent with the view that HF activists expropriate wealth from employees. Underfunding implies that a plan’s liabilities exceed its assets, potentially hurting employees after they retire. We then examine the mechanisms that lead to the underfunding of pension plans. We find that targeted firms reduce employer contributions by increasing the assumed rates of returns on plan investments and the discount rate used to compute the present value of plan obligations. Firms also tilt plan investments toward riskier assets, in a failed effort to boost plan returns. Activists typically exit the firm after 1.5 to 2 years (see Brav, Jiang and Kim (2009)), but the effect on employee pensions is long-term and persists over at least the next five years. While most of our paper deals with defined benefit pension plans, about which there are more data, we also find that target firms reduce employer contributions in defined contribution plans.
There are two potential interpretations of our findings. First, HF activists put pressure on managers to increase shareholder wealth, and managers respond by raiding employee pension funds. Second, observable and unobservable characteristics of these firms that lead activist HFs to target them also lead the firms to underfund employee pensions. We provide three types of evidence that favors the first interpretation over the second. First, our methodology is aimed at ruling out the second interpretation. Specifically, we match each target firm with a control firm, identified using a propensity score matching (PSM) procedure, which controls for observable firm characteristics. We then use a difference-in-differences (DiD) approach and draw inferences based on contemporaneous changes in treatment vs. control firms in years before and after HF activism. Within this framework, we use firm fixed effects regressions, which remove the effects of time-invariant firm characteristics, whether observable or not. Second, the magnitude of underfunding after activist campaigns is greater in subsamples where managers come under pressure from activists to do M&A deals or reform corporate governance. Third, future increases in pension underfunding explain the rise in stock price after announcement of an activist campaign, which provides a direct test of the wealth transfer hypothesis. Our back of the envelope estimates suggest that about one-half of the dollar value of shareholder wealth gains at the announcement of activism come from employee pensions.
Finally, we conduct tests of several alternative hypotheses suggested by Brav, Jiang and Kim (2015a) to disentangle the effect of HF activism from mere stock picking. These tests confirm that our results are not driven by alternative hypotheses such as voluntary reforms by management, activists’ stock-picking skills, mean-reversion, financial distress, or attrition bias.
We refer to the increase in underfunding of employee pension plans following HF activism as wealth transfers from employees for three reasons. First, these plans were already substantially underfunded, on average by 24 percent in the year before targeting (see Table 2). Second, while PBGC insures the plans in case the firm goes bankrupt, PBGC’s coverage limits are modest, up to an annual pension of about $60,000 for a 65-year-old retiree for a plan terminated in 2016. Finally, PBGC’s own financial health is in question. The U.S. Government Accountability Office (GAO) has designated PBGC’s single-employer program as “high risk” since July 2003 and added this designation to multi-employer plans since January 2009 (see U.S. GAO (2017)). These facts do not support the idea that HF activism forces managers to eliminate overfunding of pension funds of fat-cat employees. Our finding of an increase in underfunding of employee pension plans following HF activism supports the Shleifer and Summers (1988) notion of a breach of trust with employees.
Overall, our paper extends the limited literature showing that HF activism transfers wealth from other stakeholders to shareholders. Our empirical results point to a negative effect of HF activism on workers’ welfare. Finally, our findings have important implications for public guarantees and regulation of private pension plans.
 Relatedly, Grennan (2014) finds that greater shareholder governance decreases employee cooperation and integrity due to a greater focus on results.
 See Nelson D. Schwartz, How Wall Street bent steel: Timken bows to activist investors and splits in two, New York Times, December 6, 2014.
Brav, A., Jiang, W., & Kim, H. (2009). Hedge fund activism: A review. Foundations and Trends in Finance, 4(3), 185-246.
Brav, A., Jiang, W., & Kim, H. (2015a). The real effects of hedge fund activism: Productivity, asset allocation, and labor outcomes. Review of Financial Studies 28 (10), 2723–2769.
Brav, A., Jiang, W., & Kim, H. (2015b). Recent advances in research on hedge fund activism: Value creation and identification. Annual Review of Financial Economics 7, 579-595.
Boyson, N., Gantchev N., & Shivdasani, A. (2017). Activism mergers. Journal of Financial Economics, 126(1), 54-73.
Coffee, J. C., & Palia, D. (2016). The wolf at the door: The impact of hedge fund activism on corporate governance. Annals of Corporate Governance, 1(1), 1-94.
Grennan, J. A. (2014). A corporate culture channel: How increased shareholder governance reduces firm value. Working Paper, SSRN.
Klein, A., & Zur, E. (2011). The impact of hedge fund activism on the target firm’s existing bondholders. Review of Financial Studies, 24(5).
Shleifer, A., & Summers, L. H. (1988). Breach of trust in hostile takeovers. In Corporate Takeovers: Causes and consequences, University of Chicago Press, 33-68.
United States Government Accountability Office. (2017). High risk: PBGC insurance programs, GAO report # 17-317.
This post comes to us from professors Anup Agrawal at the University of Alabama’s Culverhouse College of Business and Yuree Lim at the University of Wisconsin-La Crosse’s College of Business Administration. It is based on their recent paper, “The Dark Side of Hedge Fund Activism: Evidence from Employee Pension Plans,” available here.